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Will Holiday Shoppers Be Merry or Miserly?

For retailers and consumer-focused businesses, it's now time for what Mattel (MAT) Chief Executive and Chairman Robert Eckert calls "the early fall jitters."

The 2009 holiday season is approaching quickly, and with nearly 1 in 10 Americans officially out of work there are plenty of reasons to be worried. As merchandise is being shipped to them, stores have no guarantee that shoppers will show up to buy. Fears are heightened by memories of last year's disastrous fourth quarter.

"We're coming off probably the worst holiday season in memory," says Doug Hart, a partner in the retail practice at BDO Seidman, an accounting and financial services firm.

Holiday retail sales dropped 3.8% last November and December, reflecting consumer panic as the U.S. navigated through an unprecedented financial crisis.

Although many economists believe that the U.S. economy ended its recession during the summer, few expect consumer spending to bounce back. The National Retail Federation predicts holiday sales to fall a further 1% this year. After almost two years of recession, Americans have less money to spend. For retail analysts such as Wayne Hood at BMO Capital Markets, "Real income growth is the most important driver."

Consumers still cutting back?Retailers know this and are being cautious. "Retailers continue to be reluctant to make inventory bets and it will undoubtedly be a difficult holiday for parents whose job status and financial well-being are uncertain," said Mattel's Eckert, speaking to analysts after the toy giant announced quarterly results on Oct. 16.

Various surveys back up the contention that consumers remain gloomy. In a survey released by the National Retail Federation on Oct. 20, consumers said they plan to spend an average of $682.74 on holiday-related shopping this year, a 3.2% drop from last year. Mattel's rival Hasbro (HAS), told analysts on Oct. 19 that its surveys showed most consumers planning to spend at last year's levels—with a quarter intending to spend less and only about 10% contemplating an increase.

Notwithstanding the pessimism hanging over the holidays, many experts and investors sound increasingly optimistic.

"We see consumers ready to come back out again," says Mike Unger, managing director at Karabus Management, a subsidiary of PricewaterhouseCoopers that specializes in advising retailers. Tired of the recession, shoppers want to go back to stores and hunt for bargains, Unger believes.

Recent data have given small reasons to be optimistic. In September, U.S. retail sales excluding autos ticked up 0.5%, following a 1% rise in August.

But predicting the mood of the American consumer is more art than science.

Retailers are on their toes this year"You never want to underestimate the consumer," says Kelli Hill, a portfolio manager and analyst at Ashfield Capital Partners. Americans like to spend money, she notes, and they've stopped doing so for the past year. "There's just a lot of pent-up demand," she says. Americans might not be able or willing to run up their credit cards, but they're starting to realize the recession is over. So they will think: "'Let's enjoy the holiday.'"

There's even evidence that retailers might enjoy the holiday. Consumer-focused firms were stunned by last year's sudden crisis, and then profits plunged. This year they are better prepared for surprises.

Retailers have done an excellent job cutting costs, experts say. Caught with too much inventory last year, they are stocking lighter quantities this holiday season. With less merchandise on the shelves, they should need to offer fewer discounts to unload it. In addition, chains have slashed expansion plans and closed unprofitable stores, Hart says, and have even demanded rent reductions from landlords.

Analysts believe all this cost-cutting will boost profits even as sales remain flat. According to analyst estimates tracked by Thomson Reuters (TRI), consumer discretionary earnings are expected to double in the fourth quarter of 2009 from the previous year.

"The cost-cutting has been aggressive," Unger says. Retailers have "put themselves in a position where they can survive a holiday downturn if there is one."

Survival isn't an abstract question for consumer firms in this economy. Last year's grueling Christmas season drove several high-profile retailers into bankruptcy, including Circuit City.

Expect discounts, meager inventoriesIf consumer spending does recover unexpectedly, stores could run out of product faster. "If you walk into any kind of store today and you see something you like, buy it," Hill says. "Because it's probably the only one they have."

Retailers may be cautious, but that doesn't mean they won't offer discounts this holiday season. Another lesson learned over the past year, Hood says, is that consumers want good deals. "The consumer is making sure that they provide value," Hood says.

Wal-Mart (WMT) benefited from its reputation as a discounter last year, but now many other retailers are trying to get in on the act, including Macy's (M). Last year "retailers that discounted gained market share," Hart says. Store shelves should feature more gifts and products designed to sell in the $10 to $20 range, he says.

There are still few signs that U.S. consumers are planning to open their wallets wide this holiday season. Given the jobs outlook and a shortage of consumer credit, we're unlikely to see a return to the spending levels of 2007 and earlier.

But with the stock market up and the recession assumed to be over, many are betting that retailers can avoid last year's ruined holiday. Even if sales remain flat, retailers and other consumer-focused firms are at least better prepared.